Martin Bixel - 06 Feb - 0 Comments
The markets have reacted favourably to the US election result. We assess how long the share rally is going to last
Received wisdom has it that financial markets don’t like shocks. In which case, Donald Trump has just turned convention on its head once again; in the weeks since his surprise election victory, the US markets have leapt forward. All four of the main US stock market indices, including the blue-chip Dow Jones and the Russell 2000 Index of smaller companies, have hit all-time highs. The dollar is trading at its highest level against other international currencies for more than a decade. And yields on US Treasuries — the value of the income on offer on US government bonds — are at a 16-month peak.
We’ve seen the colour of his home decor, but does the president-elect have the Midas touch when it comes to markets too? Well, his promises of tax cuts for individuals and businesses, plus a comprehensive infrastructure investment programme, have certainly enthused investors, especially because so many had expected Hillary Clinton to win. Her campaign promises appeared much less supportive of markets — particularly the threat of changes to healthcare finance.
Nevertheless, Tom Stevenson, the investment director at Fidelity International, urges caution. “The swing from glass half-empty to glass half-full after Mr Trump’s victory has been dramatic and surprising,” he says. “There is much in the new deficit-spending growth story that is plausible, but it is always concerning when the investment consensus is unanimous.”
Let’s start with the positives. There are a number of different Mr Trump-related themes underpinning the strong stock market performance of recent weeks. First, investors have moved back into equities from their previously cautious positions in less risky bonds. That makes sense if Mr Trump delivers on his promise to stimulate the economy with higher spending, such as infrastructure investment. More growth and higher inflation, which normally accompanies such initiatives, naturally favour equities, while more debt is a negative for bond markets.
In addition, markets are betting that interest rate rises in the US are more likely under a Trump presidency; with the new president prepared to loosen the fiscal purse strings, the Federal Reserve will have more scope to tighten monetary policy. Higher interest rates tend to be good news for developed markets such as the US over, say, emerging markets.
Then there is the swing from defensive sectors of the US market — tobacco, food retailers and so on — into potentially more exciting cyclical stocks, which do well when the economy is growing. “Financial stocks in particular benefit from rising longer-term bond yields, since banks can borrow cheaply and lend more expensively,” says Mr Stevenson. The fact that Mr Trump has also promised to pull back on regulatory reform in the financial sector is another positive.
Against this supportive backdrop, investors should note that the US stock market is already trading on valuations that are expensive relative to other markets and to history. At present share prices, investors are estimating that US companies will deliver earnings worth 17 times their market value in 2017; that compares with 14 in the UK and much of Europe, for example. The premium is justifiable only if you believe the president-elect can double US eco- nomic growth in the way he has promised, and quickly.
Some of Mr Trump’s promises could be heavily watered down
Brian Dennehy, the head of Fund Expert, an adviser, also urges investors to scrutinise Mr Trump’s promises. “The intended spend on infrastructure is not that great; at a trillion dollars over ten years, it is only a little more than Obama put in place, which had little economic impact,” he warns.
“As for tax cuts, most will benefit the top 1 per cent, so these tax savings will tend to be saved not spent, and you can expect a large part of any saving for the 99 per cent to go to a mix of debt reduction and higher medical costs.”
Jason Hollands, the managing director of Tilney BestInvest, the wealth manager, is also sceptical about the sustainability of the US market rally, because he is worried that campaign pledges may not be deliverable. “Certain policies will only see the light of day with the support of congress, and while the Senate and House are controlled by the Republicans, Mr Trump has had a difficult relationship with the party,” Mr Hollands says. “Republicans believe in balanced budgets, whereas his policies imply deficit financing — some of his promises could therefore be heavily watered down.”
Still, if the case for a bull market is not as convincing as investors might hope, some sectors look to have stronger prospects than others. Healthcare companies, infrastructure businesses and financials should fare better. Retailers may benefit if tax cuts materialise, while defence companies have been promised increased spending. You can also bet on the US real estate sector getting favourable treatment given the president-elect’s business background.
However, there will be losers. “What happens if Mr Trump unravels Obamacare is an issue that may come further down the line,” warns Darius McDermott, the managing director of Chelsea Financial Services, of the administration’s promise to repeal healthcare reform. “Nor is he good for renewables or anything linked to halting climate change.”
Large US exporters also have reason to be nervous. The rise in the value of the dollar is hurting their competitiveness in overseas markets — those with longer memories will remember that one effect of Ronald Reagan’s “Reaganomics” programme in the 1980s, seen as similar to the Trump plan, was a rise in the dollar so strong that central banks felt compelled to intervene. Nor will Mr Trump’s disdain for free-trade agreements please international US businesses.
So where does that leave potential investors in US markets? Be circumspect, suggests Philippa Gee, of Philippa Gee Wealth Management.
“Be mindful that you could already have large US allocations through more global funds, in which case a pure US fund may not be necessary,” she says. “If you do want to go direct, you could combine a passive holding that follows the index, such as Vanguard US Equity Index, with an active fund such as Fundsmith, which has more than 60 per cent of assets in America.”
The experts’ picks
For those looking for a more specialist play on potential winners, Martin Bamford, the managing director of Informed Choice, the financial adviser, suggests Legal & General Global Health and Pharmaceuticals. “This fund could do well regardless of Donald Trump, with the important theme of an ageing population driving growth,” Mr Bamford says. “If Mr Trump’s policies give the promised boost, it could do even better.”
At Chelsea Financial Services, Darius McDermott picks out Schroder US Mid Cap and Hermes US SMID Equity, two funds that focus on medium-sized US businesses with less exposure to the strong dollar.
Tilney BestInvest’s Jason Hollands, likes T Rowe Price’s US Smaller Companies for similar reasons, or First State Global Listed Infrastructure and F&C Global Real Estate Securities as specialist plays.
Finally, Fidelity’s Tom Stevenson recommends Old Mutual North American Equity. “The fund is managed by a team headed by Ian Heslop, who combines mathematical modelling, lots of data and plenty of computing power to get an early grasp of changes in market sentiment and behaviour,” Mr Stevenson says. “It sounds technical, but the track record in recent years suggests this numbers-based method works in a market where finding an edge is traditionally difficult.”